Three sources familiar with the Bank of Japan’s internal deliberations say the central bank will likely keep its inflation warning on the table at next week’s policy meeting — but will stop short of suggesting those risks have grown.
In a quarterly outlook report set to be released at the meeting, the BOJ is expected to flag ongoing inflation concerns tied to the conflict in the Middle East, strong global demand for artificial intelligence technology, and rising import costs driven by a weakened yen.
At the same time, the bank believes the chance of a worst-case outcome — in which severe supply disruptions cause a dramatic price spike and force rapid interest rate increases — has decreased since April, the sources indicated.
“There is a risk of underlying consumer inflation deviating upward from our 2% target,” the BOJ said back in June when it raised interest rates. Sources say that same language is expected to reappear in the upcoming quarterly report.
This represents a meaningful shift in tone from April’s report, when the bank raised alarms about a “big overshoot in inflation” amid deep uncertainty following U.S.-Israeli strikes on Iran on February 28, which escalated the Middle East conflict.
After sounding that warning in April, the BOJ lifted its policy rate to a 31-year high of 1% in June.
Now that the immediate threat of an oil-driven inflation shock appears to have eased, bank officials are shifting their focus to whether businesses are continuing to pass their rising costs along to everyday consumers, the sources said.
This shift in focus indicates the BOJ is looking past the direct impact of Middle East tensions and turning its attention to broader inflation drivers — including AI-related demand and yen weakness — as it considers when to raise rates again. Analysts surveyed by Reuters anticipate the BOJ will push rates to 1.25% sometime between October and December.
“If prices rise in line with BOJ forecasts in the summer through autumn, that will lay the groundwork for the next rate hike,” said Mari Iwashita, a strategist at Nomura Securities.
At the conclusion of its two-day meeting on July 31, the BOJ is widely expected to leave interest rates unchanged at 1% and revise its economic growth outlook upward, reflecting reduced uncertainty surrounding the Middle East situation.
Core consumer inflation came in at 1.6% in June — below the BOJ’s 2% goal for the fifth consecutive month — a sign that businesses have not yet moved aggressively to shift their higher costs onto consumers.
Still, analysts expect core inflation to climb back above 2% later this year as recent increases in producer prices gradually work their way through the broader economy.
“Both upside price risks and downside economic risks appear to have subsided compared with three months ago,” one source said. A second source added, “The likelihood of the BOJ’s baseline projections materialising has increased.” The sources spoke anonymously because they were not authorized to comment publicly.
The BOJ is also expected to maintain its commitment to continuing rate increases while monitoring the economic and price effects of the Middle East conflict. However, policymakers remain split on the pace of those increases, with more aggressive members arguing there is room to tighten policy faster, while others prefer a more cautious approach.
A key factor in that debate will be whether price pressures continue to build. If higher business costs increasingly translate into rising consumer prices, the BOJ may be pushed to act sooner than markets currently expect.
More hawkish board members could also push to move up the bank’s projected timeline for reaching stable 2% inflation, which is currently estimated to occur somewhere between October of this year and March 2028.
With inflation already hovering near 2%, however, that projected timeline may become less useful as a policy communication tool. Some analysts say investors will increasingly pay attention to the bank’s assessment of inflation risks, financial conditions, and the direction of the yen.
“How the BOJ evaluates current financial conditions, including the ongoing depreciation pressure on the yen, will be important for gauging the timeline to the next hike,” said Ayako Fujita, chief economist at JPMorgan Securities Japan.
